Article

Factual Summary: Contractor/Principal contracted with State Agency/Local Beneficiary for construction of a housing development in Libya. Pursuant to the joint venture contract between Contractor/Principal and State Agency/Local Beneficiary, Contractor/Principal obtained a performance bond and an advanced-payment guarantee (Local Guarantees) in favor of State Agency/Local Beneficiary issued by Local Bank, a Libyan bank, with the performance bond at USD 3,760,387.95, and the advance payment guarantee at USD 15,021,093.25. Reimbursement of the Local Guarantees was assured by counter guarantees issued by Counter-Guarantor with values corresponding to the Local Guarantees, and whose reimbursement was subject to a credit facilities agreement (CFA) between Counter-Guarantor and Contractor/Principal.

The Local Guarantees provided that payment would be made on receipt of State Agency/Local Beneficiary’s “first written demand that this amount is due to [State Agency/Local Beneficiary] stating that [Appellee/Contractor/Principal] is in breach of [its] obligations stipulated in the [housing development contract] and the respect in which [Appellee/Contractor/Principal] is in breach.”

The counter guarantees provided that payment would be made by Counter-Guarantor on receipt of the Local Bank’s “first written demand . . . provided you confirm that you have received claim from [State Agency/Local Beneficiary] in accordance with the terms of [the performance bond].” The counter guarantees were subject to English law.

When Libyan social unrest ultimately transformed into civil war, Contractor/Principal’s crew fled Libya in February 2011, and all construction activities were suspended. One month later, the United Nations Security Council passed Resolutions 1970 and 1973, which froze the assets of Muammar Gaddafi, his close advisors, and entities they controlled.

Subsequently, with their expiry pending, State Agency/Local Beneficiary demanded payment on the Local Guarantees from Local Bank. The first demand stated “[w]e, hereby, request to extent (sic) the validity of [Local Guarantee] until 31/12/2012. Kindly confirm the same in writing within a week from the date of this letter, or liquidate the amount and credit it to our account.”

Following these demands, a series of interactions occurred between Local Bank and Counter-Guarantor, in which the Local Bank made several extend or pay demands, which did not conform to the terms of the counter guarantee. Counter-Guarantor only replied to the second such demand, stating that it did not comply. Subsequently, Local Bank made another demand on Counter-Guarantor, stating:

“We confirm that we have received the a [sic] claim for [US$15,021,093.25] from [State Agency/Local Beneficiary] in accordance with the terms of the above advance payment guarantee.

We hereby support our demand by our written statement specifying that we have received a demand for payment under the above advance payment guarantee in accordance with its terms.”

In addition, various legal maneuvers were made by Contractor/Principal and Counter-Guarantor in Singapore. Contractor/Principal obtained a preliminary injunction and declaration that it was discharged from liability to Counter-Guarantor based on its relationship with, and obligation to, the State Agency/Local Beneficiary. Subsequently, Counter-Guarantor challenged service of the injunction. These maneuvers led to another filing by Contractor/Principal for relief and an ex parte injunction, which Counter-Guarantor responded to with a counter-claim for reimbursement, or a declaration that Contractor/Principal was liable.

The trial court permanently enjoined Counter-Guarantor from receiving payment from Contractor/Principal, ruling that Counter-Guarantor’s demand was made fraudulently because it knew that it had no liability to Local Bank and that it would be unconscionable for Counter-Guarantor to claim reimbursement from Contractor/Principal. On appeal, the Appellate Court affirmed.

Legal Analysis:

  1. Fraud in Claiming Reimbursement; Reckless Behavior. The Appellate Court concluded that Counter-Guarantor “acted fraudulently, in the reckless sense” by making a demand for reimbursement under its agreement with the Contractor/Principle.

Summarizing the rationale of the fraud exception, the Appellate Court stated that it is generally “meant to safeguard the account party from a dishonest call being made upon the guarantee by the beneficiary.” The court cited a series of decisions which it characterized as ones in which injunctions were obtained on the basis of “what may be called ‘common law fraud’” of which the guarantor bank had notice. The Appellate Court looked to the English decision of Derry v. Peek, in which Lord Herschell stated that, to prove fraud a false representation, it must be shown that it was made (i) knowingly; (ii) without belief in its truth; or (iii) recklessly. Recklessness was explained as being “indifferent as to whether it is true or false.” The court suggested that recklessness was “an instance of” not having belief in the truth of what was represented. With respect to letters of credit, the court stated that “a beneficiary that presents an invalid demand under a demand guarantee recklessly, that is to say indifferent to whether it is or is not a valid demand, would also be acting fraudulently.”

Noting that the underlying conceptual basis of the fraud exception was the maxim that “fraud unravels all,” the Appellate Court concluded that “there should be no distinction in the operation of the fraud exception in the context either of letters of credit or of demand guarantees.”

The Appellate Court observed that there was a “contractual basis” for the exception, in that the law implied a contractual term that there should not be payment when there was fraud. The court stated that “[i]n our judgment, the fraud exception should apply where, (1) the beneficiary’s demand is in fact shown to be invalid; and (2) regardless of any fraud on the part of the beneficiary, it can be shown that the guarantor bank is itself acting fraudulently in either paying the beneficiary and/or in asking to be indemnified by the account party because it either knows or has no honest belief that it is obliged to pay the beneficiary under the demand made by the beneficiary or is recklessly indifferent to that question.” The court suggested that this rule would not unduly widen the liability of banks because it would only apply when the bank was aware of the fraud. The opinion stated that, in the case at hand, the applicant “would have to show that the guarantor bank was acting fraudulently in asserting its contractual rights.”

The Appellate Court stated that the Contractor/Principal “would have to show that the only realistic inference to be drawn on the available evidence is that the guarantor bank had no honest belief that it was obliged to pay the beneficiary or was recklessly indifferent as to whether it had to pay…We expect that it would only be in truly exceptional circumstances that the account party would be able to discharge this high standard of proof.”

The Appellate Court noted that establishing that the Local Bank acted fraudulently would not suffice to defeat the Counter-Guarantor’s claim for reimbursement. The opinion stated that the Contractor/Principal would have to show that the Local Bank acted fraudulently and that, in seeking to honor that demand, the Counter-Guarantor “was acting fraudulently (in any relevant sense of that term).”

The Appellate opinion listed the following reasons for its conclusion that the Local Bank had acted fraudulently, emphasizing that they were cumulative:

  • The demand on the Local Guarantee was “obviously non-compliant.”
  • The Local Bank made demands on the basis of a non-complying demand under the Local Guarantee. The Appellate opinion discounted the possibility that there was negligence by the Local Bank’s clerk.
  • The Local Bank was recklessly indifferent as to the truth or falsity of the demands contained in its claim under the counter guarantee.
  • The Court is “entitled to rely on [Local Bank’s] failure to answer the allegations of abusive conduct and fraud that were made against it to draw the inference that it acted fraudulently in making the CG Demands.”

The Appellate opinion also listed the following reasons for its conclusion that the Counter-Guarantor was recklessly indifferent regarding its obligation to pay the Local Bank, noting the reasons were considered cumulatively:

  • Counter-Guarantor dealt regularly with demand guarantees.
  • Counter-Guarantor was aware that its obligation under the counter-guarantee “would only be triggered if [Local Bank] had received conforming demands from [Local Beneficiary” because Counter-Guarantor had indicated to the Local Bank that it was necessary to state that it had received a complying claim from State Agency/Local Beneficiary.
  • Counter-Guarantor eventually received the Local Guarantees.
  • Counter-Guarantor was aware that the Contractor/Principal challenged the entitlement of State Agency/Local Beneficiary to draw on the Local Guarantees.
  • Counter-Guarantor obtained copies of the presentations from State Agency/Local Beneficiary to the Local Bank.
  • These demands by State Agency/Local Beneficiary on the Local Bank were “manifestly non-compliant.”
  • Counter-Guarantor had demonstrated that it was aware that “that the obligations of the various parties along the banking chain would only be triggered upon the receipt of conforming demands at every stage.”
  • The opinion recited that, “[i]n the circumstances, we consider that it would have been indefensible for [Counter-Guarantor] to turn a blind eye to the documents in its possession. Indeed, this would be a pointed example of reckless indifference on the part of a guarantor bank as to whether it in fact had an obligation to pay the beneficiary under the demand guarantee. The ‘moral obliquity’ of such conduct that warrants the label of fraud and the consequences that flow therefrom lies in the guarantor bank’s wilful disregard of the question of whether it was obliged to pay the beneficiary under the demand.”

  1. Unconscionability. Noting that the decision about recklessness rendered it unnecessary to consider whether unconscionability “can form the basis for an order restraining [Counter-Guarantor] from receiving payment from [Contractor/Principal] on facts such as the present where there has been a full trial and determination of [Contractor/Principal’s] liability to [Counter-Guarantor] under the FA Demand” pursuant to the reimbursement agreement, the Appellate opinion did offer some “observations” for the future.

  • The performance bond is to be paid on demand and to permit the parties to the underlying transaction to sort matters out later.
  • Notwithstanding the above point, “there is a potential for it to be used as an ‘instrument of oppression.’”
  • “[T]he unconscionability exception exists because we recognise that in certain circumstances, even where the account party cannot show that the beneficiary had been fraudulent in calling on the bond, it would nevertheless be unfair for the beneficiary to realise his security pending resolution of the substantive dispute.”
  • The case before the Appellate Court “does not fall squarely within the type of situation envisaged.” The opinion noted that the case involved a contract to reimburse and not a performance bond, and also, that there has been no determination of the dispute between Local Beneficiary and Contractor/Principal.

  1. The Remedy. Counter-Guarantor argued that a permanent injunction would prohibit it from claiming reimbursement if it was found liable to Local Bank in the appropriate forum. The Appellate Court rejected this argument, concluding that the issue had been decided on the merits and pointing out that Local Bank could have been joined in the action, a step which it did not take.

  1. Injunction. Counter-Guarantor requested a conditional injunction in place of the permanent injunction granted by the trial judge arguing the permanent injunction constituted an undue burden as it could be found liable to Local Bank since England was the appropriate jurisdiction under the counter-guarantee. The court rejected Counter-Guarantor’s request. The Appellate Court concluded that, because Counter-Guarantor consented to Singapore’s jurisdiction when it sought counter-relief against Contractor/Principal, Counter-Guarantor should have moved to join Local Bank in the Singapore action.

Comments:

  1. Reimbursement Contract, Not LC. The most significant fact about the Boustead opinion is that the court uses the type of analysis appropriate to a letter of credit for a reimbursement contract between the Counter-Guarantor and Applicant, determining that what appears at most to be a breach of contract, constitutes fraud as a result of reckless behavior, and grants a permanent injunction against the bank reimbursing itself.

TEXTS:

Excerpts from the Local Guarantee from the Opinion:

“[Local Banks’s] obligation to pay [State Agency/Local Beneficiary] under the PB is stated in the following terms:

We [Local Bank] agrees (sic) to make immediate payment to [State Agency/Local Beneficiary] of [any sum not exceeding US$3,760,387.95]…upon receipt of [State Agency/Local Beneficiary’s] first written demand that this amount is due to [State Agency/Local Beneficiary] stating that [Contractor/Principal] is in breach of [its] obligations stipulated in the [Public Works Contract] and the respect in which [Contractor/Principal] is in breach.” [¶ 10]

“[Local Bank’s] obligation to pay [State Agency/Local Beneficiary] under the APG is expressed in similar terms as follows:

We [Local Bank] agrees (sic) to make immediate payment to [State Agency/Local Beneficiary] of [any sum not exceeding US$18,331,891.37] on receipt of [State Agency/Local Beneficiary’s] first written demand stating that [Contractor/Principal] has failed to repay the advance payment in accordance [with] the conditions of the [Public Works Contract], and the amount which [Contractor/Principal] has failed to repay.” [¶ 12]

Excerpts from the counter guarantee from the Opinion, both of which were in identical operative terms:

“[Counter-Guarantor’s] obligation to pay [Local Bank] under CG38 is stated in the following terms:

In consideration of your issuing [the PB], we hereby unconditionally and irrevocably undertake to reimburse you on your first written demand communicated through authenticated SWIFT message or registered mail, despite any contestation on the part of [Boustead]…provided you confirm that you have received claim from [State Agency/Local Beneficiary] in accordance with the terms of [the PB]…Such demand shall be supported by a written statement specifying that you have received a demand for payment under [the PB] in accordance with its terms.” [¶ 14]

Excerpts from agreement between Arab Bank (Counter-Guarantor) and Boustead (Appelllee/Contractor/Principal):

“6.8 No Liability: [Counter-Guarantor] shall have no obligation whatsoever to make any factual determinations as to the validity or genuineness or notice or accuracy or correctness of any certificate or statement or notice or other document delivered with respect to or under any [bank guarantee [Counter-Guarantor] shall issue pursuant to [Contractor/Principal’s] request] (whether by the beneficiaries of the [bank guarantee] thereof or otherwise) or as to any other matters before making payment under any [bank guarantee].” [¶ 16]

Clause 6.9 requiring Contractor/Principal make payment to Counter-Guarantor’s immediately upon demand:

“…[Contractor/Principal] hereby undertakes and agrees with [Counter-Guarantor] that it shall immediately and upon demand from [Counter-Guarantor] (which demand shall, in the absence of manifest error, be conclusive evidence of the amount owing), reimburse and/or indemnify [Counter-Guarantor] for any amounts demanded or paid under any [bank guarantee Counter-Guarantor shall issue pursuant to [Contractor/Principal’s] request]…[Contractor/Principal’s] obligations to pay such amount demanded by [Counter-Guarantor] shall be absolute and unconditional irrespective of any…disputes of [Contractor/Principal] concerning the merits or validity or propriety of any such demands or claims or any payment made.” [¶ 17]

Counter-Guarantor’s response to Local Bank’s extend or pay demand:

“Kindly note, your request does not constitute a complying demand as per the terms of [CG39].

For a demand to be complying under [CG39], you have to confirm that you have received claim from [State Agency/Local Beneficiary] in accordance with the terms of the [APG]…Such demand should be supported by a written statement specifying that you have received a demand for payment under the above [APG] in accordance with its terms.” [¶ 25]

Demand under Counter Guarantee:

“… We hereby demand [US$15,021,093.25], under [CG39] which please credit our US Dollars account with your goodselves.

We confirm that we have received the a [sic] claim for [US$15,021,093.25] from [State Agency/Local Beneficiary] in accordance with the terms of the above advance payment guarantee.

We hereby support our demand by our written statement specifying that we have received a demand for payment under the above advance payment guarantee in accordance with its terms.” [¶ 28]

[MJK]

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The views expressed in this Case Summary are those of the Institute of International Banking Law and Practice and not necessarily those of the ICC or Coastline Solutions.